Important Announcement

Trade of the Week - Iron Condor (7/1/2009)

I put this iron condor trade on 7/1/2009 for a credit of $1.09. We are selling the August 98/96/88/86 spread. Breaking it down, that's a 98/96 call spread and the 88/86 put spread.

Iron Condor on the SPY trade of the week

SPY Aug Iron Condor 98/96/88/86
1. Exit if I can lock in 60% of my initial credit (i.e. 71% ROI)
2. Exit 4-7 days before expiration
3. Exit individual sides if I can close for < $.20

The nice thing about this trade is that it has a $2 wide spread, which would be the maximum loss this trade could sustain, but I took in $1.09, so my total risk in the trade is only $.91.

Why this strategy?

I chose to do an iron condor because it appears as though the SPY (and the market in general) may be moving into more of a sideways trend. I'm noticing that the SPY peaked in mid June and then pulled back to the 50 day and 200 day MA before bouncing up and eventually forming a shorter term higher high. We may not reach the highs around 95-96 before pulling back... maybe even to the 200 day MA again. In this kind of market where the expectation is for a stock or ETF to remain range bound, an iron condor is the perfect trade.

Choosing the right strike prices

I'm using one of the strategies I talked about on my iron condor strategy page. This strategy involves selling options with a delta of around .30-.35 or a probability of expiring around 30-40%. This is a higher return but lower probability of success trade. In the picture below, I've circled the probability of expiring. I captured this at the close of the day after SPY had pulled back a little so the numbers are skewed from when I took the trade mid day.

Iron Condor probability of expiring

One interesting point about calculating my probability of success on this trade... I could come up with this number a variety of different ways. Having a probability of expiring of around 32% on each side would mean I have a probability of success of 68% on each side, but what about the total position?

A quick 'rule of thumb' way to calculate this is by taking my current risk in the trade ($.91) and divide it by the total risk ($2). That would result in a 45% probability of success. Another way to calculate this probability is using the analysis tab on the thinkorswim platform.

Iron Condor probability of success

With this tool, the probability of success is calculated to be closer to 38.8%. Success is defined as being between the two break even points on expiration. This trade probability will probably be slightly better than this based on the fact that I won't hold until expiration and I will close out if I can lock in 60% of the initial credit.

Position sizing

I already know going into the trade what I stand to lose ($.91 - or $91/contract). On a $20,000 account, I will risk just 1% on this trade or $200. Therefore, I can take 200/91, or 2 contracts. Why only 1%? In this market, iron condors have been a bit more of a risky trade. On top of that, I am concerned with a larger selloff that would totally destroy this trade.

Note on position sizing: As a rule, it is best to maintain a consistent % risk for every trade, however there are times when it is appropriate to scale back the  position size.

Exit plan

My exit plan is to exit when one of several things occur.

  1. I can lock in around 60% of the credit - meaning I close for around $.43 debit
  2. I'm within 4-7 days of expiration
  3. Exit individual sides if I can close for < $.20

In this particular trade, I have no plan to exit if the trade goes completely against me. I've already positioned sized for the maximum loss so there is nothing else to do in that regard. However, if the trade goes against me one way or the other, I will look to close the opposite side for around $.15-.20.

Update 7/8/2009

One week into the trade, we've seen quite a pullback. With the pullback additional volatility has been introduced into the options premium. Even still, the position has a slight profit as we saw the benefit of a week of time decay. Looking at potential exits, I said the exit plan was to exit if I can lock in 60% of the credit or if I can close an individual side for < $.20. Currently, the call side can be closed for $.30. Neither condition has been met so I'll not be making any adjustments.

Advanced options portfolio strategy: One strategy I can employ if I'm concerned about seeing the underlying fall through my put spread or rising above my call spread is to buy a calendar spread in the general area. I'd buy a call calendar near the call spread or a put calendar near the put spread.  This has the effect of pushing out the break even price on the side where the calendar was purchased.  Keep in mind that this strategy comes with a price. If I'm wrong, I'll be giving back the cost (or part of the cost) of the calendar.  I will usually buy fewer contracts of the calendars than I have contracts of the spread I'm protecting.

Update 7/15/2009

This trade had a close call the end of last week with the large pullback.  I was actually within a penny or two of being able to cover the call spread for $.20 as per my exit plan above.

Iron Condor Trade of the Week review

Right now the stock is right back to where it was when I put the trade on, but has gained almost $.20 in value. Put another way, this trade has seen a theta decay of $.20 over the last two weeks. Before this trade is finished, it wouldn't surprise me to see SPY move up and touch (or penetrate) the upper side if our iron condor.

Update 7/21/2009

As per my exit plan, I closed out the put spread for a $.19 debit... actually a penny below my exit plan. I was able to get this executed first thing this morning as the market opened up. That leaves me with a short vertical call spread that has some negative delta. What this means is that what remains of the original iron condor position will benefit from a move down in SPY. With the large move up over the last week, I'm expecting to see some sort of pullback in the next few days, which will really help this position. With the positive theta still on this trade, I'll be making money even if the SPY goes nowhere.

Update 7/29/2009

The SPY has continued to climb and has now pushed through the upper side of the iron condor.

Iron Condor Trade of the Week review

It would be easy to panic when this kind of thing happens. In fact, it happened earlier on the lower side. What keeps me in this trade and what keeps me from panicking?  My trading rules.

My iron condor exit rules that I established before I ever put the trade on (or shortly after I put the trade on in this case) dictated that I would only exit if I'm within 4-7 days of expiration, I can close to lock in 60% of the initial credit (which would mean closing for $.23) or if I could close one side for less than $.20.

I already took in $1.09/contract on the credit, which means my max loss initially was $.91. However, I paid $.20/contract to close my puts so now my remaining credit is $.89 leaving my maximum loss at $1.11/contract. I have two contracts on so my max loss is $222 on a portfolio of over $20,000. Can I live with that loss? Yes, it's only about 1% of my portfolio. That's what keeps me in the trade and allows me to not panic.

Who knows... the market could take another U-turn and this will turn into another winner.

Update 8/5/2009

The market has continued its march up and through the upper strike area. There's not much to comment on. Just the emotions tied with having a trade that looks like a loser. I mentioned last week that it's my trading rules that keeps me in the trade and doing what I'm supposed to do. However, the question remains... how do you handle watching a trade go against you?

It's still hard for me. However I try to keep it all in perspective. When I go back and look at my trade log, I get a perspective of ALL my trades, not just the one I'm dealing with at the moment that happens to be failing. I don't have a lot of trades on my option trading tutorial page yet so it's a little hard to have much of a longer term perspective, but that will come in time. If you are keeping a trade journal as I am, it should go back through months of trades and this is where the perspective comes from.

At this point I need the SPY to drop at least $4 to be below my short strike again. This isn't impossible, especially since the SPY has moved so strongly up without much of a pause. This is the risk of an iron condor and why I only put on a 1% position.

Update 8/12/2009

There was a nice pullback yesterday that may provoke a change in trend. The SPY closed today at 99.73. To be out of the money on my short strike, I need a move of another $4 down, the equivalent of about $40 S&P points. This certainly could happen, but there are only about 3 trading days left this week.

One of my rules for exit is 4-7 days prior to expiration. The latest would be Monday or Tuesday of next week. IF the SPY continues to pull back, then there is a chance this iron condor trade could turn into a winning trade. As it stands, it would cost me about $1.58 to exit. With the $.20 I already paid minus the credit of $1.09, this trade would lose $.69.

Let's see what this pullback does. After such an extended move up, I'd sure expect more of a give back than we've seen to date. At this point the 30 day moving average is at about $95. A pull back to somewhere in that area would not be unreasonable. Remember, I sized this iron condor position for a max loss and it was only a 1% position on top of that.

Update/Trade Close 8/19/2009

Well, this iron condor trade is finally complete, a month and a half after I first put it on. In the process SPY has moved around quite a lot, breaking through both my short call and short put at one point or another.

I want to do a quick analysis on the trade before wrapping up with some lessons learned. I originally put this trade on for $1.09/contract with $.91 of risk. I took two contracts. Today, I closed the call side for a $1.90 debit. In addition, I closed the put side of the spread some time back for $.20 making my total debit to close the trade $2.10. So my loss in the trade was $1.09 - $2.10 = - $1.01 or $202 since I took two contracts.

This trade is the first losing trade I've had since starting the trade of the week series. Will it be
be the last? I don't think so. My goal isn't to have 100% successful trades since I can't guarantee that aspect of the trade. Instead, my goal is to make sure that I have enough successful gains that my account keeps growing and manage my losses so that they don't wipe out my gains. In this case, I lost just 1% of my total portfolio of $20,000. I think I can live with that.

Could I have done anything differently on this trade? One thing I've considered is what I could have done when SPY was pushing on the put side of my iron condor. Back in early July, SPY was trading down through my $88 short put but my call spread was trading at near $.20 - my exit goal for closing one side of the spread.

What kept me from not just giving a penny or two extra and closing? I kept asking myself, "what if SPY continues to sell off?". I decided to wait a little longer and by that time the SPY turned around. What could I have done instead? On thing I could have done is split the difference by closing one of the spread contracts for $.22 and let the other run. If I'd have done that, My outcome would have been different. My total closing cost would have been $40 (for the 2 put spreads) + $22 (for the one call spread closed early) + $190 (for the remaining spread = $252. So, my total loss would be $218 - $252 = -$34.

What will I do differently in the future? First, I will make sure to add this split strategy to my list of possible exits to consider. Second, I'll be looking at my exit strategy a little more closely to see if maybe I should relax my closing target from absolute numbers (i.e. $.20) to a percentage of the credit.

Note: This trade discussion is for educational purposes only. I am NOT making any recommendations on the trade or the underlying stock or ETF. If you decide to follow this trade, please do so in a paper trading account. Trading options involves risk and some options strategies can result in losing more than the original amount invested.

thinkorswim, Division of TD Ameritrade, Inc. and Success With Options are separate, unaffiliated companies and are not responsible for each other's services and products.

[?] Subscribe To This Site

follow us in feedly
Add to My Yahoo!